Regarding: A proposal to allow a $500,000 exclusion of gain from
the sale of a principal residence (Clinton proposal, with a
clarification for divorces or legal separations)

PRESENT LAW

Gain on the sale or exchange of a principal residence generally is
includible in gross income and is subject to a maximum rate of 28
percent. If an individual purchases a new principal residence within
two years of selling the old residence, gain from the sale of the old
residence (if any) is recognized only to the extent that the
taxpayer’s adjusted sales price exceeds the taxpayer’s cost of
purchasing the new residence (sec. 1034).

In general, a taxpayer may exclude from gross income up to
$125,000 of gain from the sale or exchange of a principal residence
if the taxpayer (1) has attained age 55 before the sale and (2) has
used the residence as a principal residence for three or more years
of the five years preceding the sale. This election is allowed only
once in a lifetime unless all previous elections are revoked. For
these purposes, sales on or before July 26, 1978 are not counted
against the once in a lifetime limit.

Only one spouse is required to satisfy those tests in order to be
eligible for the exclusion, but that spouse alone must meet all the
requirements. Married couples are entitled to only one $125,000
exclusion between them if they file jointly; if they file separately,
they are entitled to only $62,500 each. Unmarried individuals are
each entitled to exclusions of $125,000. The Section 121 exclusion
was increased from $100,000 to $125,000 in 1981. It has not been
changed for the effects of inflation since that time.

President Clinton has proposed to repeal the section 121 exclusion
and section 1034 rollover rules and replace them with a $500,000
married/$250,000 single exclusion of gain on the sale of a home. It
would be available once every two years.

RECOMMENDED CHANGE

Section 121 would be amended so that taxpayers of any age would be
eligible for an exclusion up to $500,000 per residence for the gain
from the sale of a principal residence. This exclusion would be
available to taxpayers once every two years. No filing would be
required for selling prices up to $500,000 if no prior sale occurred
within two years.

The exclusion would be allowed if the residence was the principal
residence of either of the spouses at the time of legal separation or
divorce. The exclusion would apply if the residence was sold pursuant
to a divorce decree or legal separation. Related provisions, such as
the home mortgage interest expense deduction, would also apply in
these cases of divorced or separated taxpayers if the residence was
one of the spouse’s principal residence at the time of divorce or
legal separation.

The current law $125,000 one-time exclusion for gain on sale of
residence by qualifying taxpayers that are age 55 or older would be
eliminated. The current law section 1034 two year rollover provision
for deferral of gain on sale of principal residence would also be
eliminated.

REASON FOR CHANGE

The principal residence is the major asset for most middle-income
taxpayers. The increase in value reflected in this asset is in most
cases, not a true economic gain. Rather, it represents the impact of
inflation on the original purchase price of the asset. The
recommended change would simplify the recordkeeping and tax payment
process for over 60 million homeowners. Older couples selling their
home for retirement income or to move into a smaller apartment or to
live with family and who have a gain exceeding the current $125,000
one-time exclusion would be able to exclude their gain and keep more
of the funds for retirement and elderly care needs. This proposal
would assist in the preservation of capital so important to elderly
taxpayers in the retirement years. This provision would allow the
elderly to remain in their homes longer and be more self sufficient.
Middle class families changing jobs and moving to communities with
lower housing costs would be able to exclude the gain up to $500,000
and thus use the money for other household needs. In addition, inner
city and rural communities with low housing costs could be more
attractive to homeowners wishing to purchase a home and keep some of
the gain for other purposes.

There are many taxpayers who are going through divorces and legal
separations that take more than two years to complete. The divorce
process is difficult and stressful, without considering the unfair
tax consequences that often result under current law. In most divorce
situations, one spouse must leave the marital residence several
months or years prior to the residence being sold or the divorce
finalized. In fact, many divorced taxpayers do not sell the residence
that was their "principal residence" until the children are finished
with their education.

This change would recognize that taxpayers marry, buy homes, and
often have many problems in dissolving the marriage, the least of
which should be the tax ramifications. Divorced and separated spouses
should have the benefits of gain exclusion. This provision would
clarify that divorced taxpayers no longer residents of a principal
residence may exclude up to $500,000 of gain per residence if the
residence was the principal residence of either spouse at the time of
legal separation or divorce and would overrule the court positions in
Young and Perry. Intervening time between when a spouse moves out of
the residence and the sale would not prevent the spouse from
excluding up to $500,000 of gain on the sale of the residence.

2. PROPOSAL FOR
AMENDING I.R.C. §121

Regarding: A proposal to increase the one-time exclusion of gain
from the sale of a principal residence by taxpayers that have
attained age 55 and age 65.

PRESENT LAW

Section 121 provides for an election to exclude up to $125,000 of
gain from the sale of a principal residence if the taxpayer is at
least age 55 and has owned and resided in the residence for at least
three of the preceding five years. Only one spouse is required to
satisfy those tests in order to be eligible for the exclusion, but
that spouse alone must meet all the requirements. Married couples are
entitled to only one $125,000 exclusion between them if they file
jointly; if they file separately, they are entitled to only $62,500
each. Unmarried individuals are each entitled to exclusions of
$125,000. The Section 121 exclusion was increased from $100,000 to
$125,000 in 1981. It has not been changed for the effects of
inflation since that time.

RECOMMENDED CHANGE

Section 121 would be amended so that the exclusion for the gain
from the sale of the principal residence by a taxpayer age 65 and
over at the time of the sale, who otherwise meets the requirements of
Section 121, would be $200,000. The current $125,000 exclusion would
be kept in place for qualifying taxpayers that are ages 55 to 64.
Taxpayers would only be able to claim one exclusion during their
lifetime, whether during the ages of 55-64, or at age 65 or older.

In addition, both the $125,000 and $200,000 exclusions would be
indexed for inflation annually using rules similar to those contained
in Section 1(f)(3).

REASON FOR CHANGE

When section 121 was created, Congress recognized that the age of
taxpayers was important for exclusion of gain on the sale of
residence. It was clear that this provision was designed to assist
elderly taxpayers. Since that time, the elderly population in this
country is increasing. The $200,000 second tier exclusion would
benefit those taxpayers with a dwindling ability to work and bring in
additional income.

The principal residence is the major asset for most middle-income
taxpayers. The increase in value reflected in this asset is in most
cases, not a true economic gain. Rather, it represents the impact of
inflation on the original purchase price of the asset. In general,
older taxpayers tend to own their homes for a long period of time and
have had their home sale gains more affected by inflation.

At the time that most elderly taxpayers sell their principal
residence, they are counting on the proceeds from the sale to cover
their living costs during their retirement years. As a result, they
are unable to meet the reinvestment requirements of Section 1034 to
defer the gain on the sale of the principal residence and are often
subject to income tax on the gain. The income taxes due from the sale
of the residence reduces the funds available to pay for retirement
needs. This proposal would assist in the preservation of capital so
important to elderly taxpayers in the retirement years. This
provision would allow the elderly to remain in their homes longer and
be more self sufficient.

3. PROPOSAL FOR
AMENDING I.R.C. §121

Regarding: A proposal for marriage penalty relief for the one-time
exclusion of gain from sale of principal residence for certain
spouses

PRESENT LAW

In general, a taxpayer may exclude from gross income up to
$125,000 of gain from the sale or exchange of a principal residence
if the taxpayer (1) has attained age 55 before the sale and (2) has
used the residence as a principal residence for three or more years
of the five years preceding the sale. This election is allowed only
once in a lifetime unless all previous elections are revoked. For
these purposes, sales on or before July 26, 1978 are not counted
against the once in a lifetime limit. The current $125,000 amount
applies to all taxpayers except those married filing separately, for
which the amount is $62,500.

RECOMMENDED CHANGE

Section 121 would be amended to allow a $125,000 exclusion to an
individual who otherwise qualifies for an exclusion under section 121
of the Code but for a marriage to a spouse who has previously made
the section 121 election. The exclusion would only be available if
the individual held the property which is the subject of the
exclusion for at least three years. Also, the $125,000 amount should
be indexed annually for inflation.

REASON FOR CHANGE

Present law contains a marriage penalty that needs to be
corrected. Under present law, a well informed individual may make a
section 121 election immediately before marriage to another
individual (who has previously made a section 121 election) to
exclude up to $125,000 of gain on a principal residence owned before
marriage. However, a less knowledgeable and less informed, but
otherwise similarly situated individual, who does not make the
election before said marriage is denied the $125,000 exclusion.
Taxpayers are being disadvantaged under present law when they marry
someone who has already taken the exclusion prior to the marriage.
The AICPA believes that on a remarriage, where one of the spouses has
never taken the $125,000 exclusion, that individual and spouse should
be able to take the $125,000 exclusion on a joint return regardless
of whether one of the spouses has previously taken the exclusion
prior to the marriage.

This change would preserve the current law’s intent and would
remove the current law "marriage penalty/tainted spouse" effect
common with second marriages. The majority of Americans rely on the
equity build up in their primary residence for their retirement
income. Allowing individuals to preserve the gain on the sale of
their primary residence provides the means to economic independence
in senior years -- a laudable result of this tax law modification.

4. PROPOSAL FOR
AMENDING I.R.C. §1034

Regarding: A proposal to allow certain divorced or separated
spouses the rollover of gain from the sale of a principal residence
by taxpayers that have reinvested the proceeds

PRESENT LAW

Current §1034 allows a taxpayer who sells a personal
residence to defer any gain on the sale by purchasing a new
residence. The taxpayer must purchase the new residence within the
period beginning two years prior to the sale and ending two years
after the sale. To completely defer the gain, the purchase price of
the new residence must equal or exceed the sale price of the old
residence.

A second rule, in code §121, allows taxpayers who are 55 or
older to exclude gain of up to $125,000 on the sale of a principal
residence that they have occupied for 3 of the 5 years prior to sale.
This exclusion may only be used once by a taxpayer and spouse.

In the case of Young v. Commissioner, T.C. Memo 1985-127, the Tax
Court held that the taxpayer abandoned the principal residence when
the taxpayer left the marriage, and, therefore, was not eligible for
section 1034 rollover treatment on the subsequent sale of the
interest to the ex-spouse. In a more recent case, Perry v.
Commissioner, 78 AFTR2d par. 96-5203, the taxpayer argued that the
sale of the home was prevented by external circumstances out of the
taxpayer’s control, similar to circumstances in the Green v.
Commissioner, T.C. Memo 1992-439, case because the family law court
would not allow the taxpayer to evict the ex-spouse and child in
order to sell the residence at the time that the taxpayer left the
marriage. The Perry court ruled that divorce is not the type of
external, objective circumstance that allows a taxpayer not in
possession of a home to be deemed a resident therein for purposes of
section 1034(a).

RECOMMENDED CHANGE

The rollover of gain on the sale of a residence would also apply,
in the case of divorced or separated taxpayers selling homes and
reinvesting the proceeds, if the residence was one of the spouse’s
principal residence at the time of divorce or legal separation. The
rollover would apply if the residence was sold pursuant to a divorce
decree or legal separation. Related provisions, such as the home
mortgage interest expense deduction, would also apply in these cases
of divorced or separated taxpayers if the residence was one of the
spouse’s principal residence at the time of divorce or legal
separation.

REASON FOR CHANGE

Congress created the section 1034 rollover provision to allow some
relief to taxpayers selling homes and reinvesting proceeds. There are
many taxpayers who are going through divorces and legal separations
that take more than two years to complete. The divorce process is
difficult and stressful, without considering the unfair tax
consequences that often result under current law. In most divorce
situations, one spouse must leave the marital residence several
months or years prior to the residence being sold or the divorce
finalized. In fact, many divorced taxpayers do not sell the residence
that was their "principal residence" until the children are finished
with their education.

Section 1034 needs to be modified to be available to divorcing
taxpayers who move out of their home because of domestic relations
problems several years prior to the actual sale. This change would
recognize that taxpayers marry, buy homes, and often have many
problems in dissolving the marriage, the least of which should be the
tax ramifications. Divorced and separated spouses should have the
benefits of section 1034. This recommended change would clarify that
divorced taxpayers no longer residents of a principal residence may
claim section 1034 treatment if the residence was the principal
residence of either spouse at the time of legal separation or divorce
or was sold pursuant to a divorce decree or legal separation and
would overrule the court positions in Young and Perry. Intervening
time between when a spouse moves out of the residence and the sale
would not prevent the spouse from deferring gain on the sale by
purchasing a new residence.

5. PROPOSAL FOR
AMENDING I.R.C. §1034

Regarding: A proposal to allow payments to CCRCs to be included in
the proceeds reinvested in a new residence (i.e., qualified rollover)
for purposes of deferral of gain from the sale of a principal
residence

PRESENT LAW

Current §1034 allows a taxpayer who sells a personal
residence to defer any gain on the sale by purchasing a new
residence. The taxpayer must purchase the new residence within the
period beginning two years prior to the sale and ending two years
after the sale. To completely defer the gain, the purchase price of
the new residence must equal or exceed the sale price of the old
residence.

A second rule, in code §121, allows taxpayers who are 55 or
older to exclude gain of up to $125,000 on the sale of a principal
residence that they have occupied for 3 of the 5 years prior to sale.
This exclusion may only be used once by a taxpayer and spouse.

The IRS has ruled that payments for admission to a retirement
facility do not qualify as the purchase of a residence (Rev. Rul.
60-135, 1960-1 C.B. 298). The taxpayer in such a situation obtains
future support and does not acquire title to real estate; therefore,
the deferral rules do not apply.

RECOMMENDED CHANGE

The rollover of gain on the sale of a residence would also apply
to taxpayers selling homes and using the proceeds to make a deposit
(i.e., fee that is not applied to monthly maintenance costs) to a
continuing care retirement community. The payment of a deposit in
connection with a continuing care contract, as defined in section
7872(g)(3), would be treated as a purchase of a new residence under
§1034. If a deposit fee is refunded to the taxpayer, the refund
would be treated as proceeds from the sale of a residence, and the
corresponding gain from the refund could be deferred if reinvested in
another residence within the two years required under §1034.

REASON FOR CHANGE

Taxpayers who enter continuing care or retirement facilities
generally are at a point where they need the care provided and are
not able to manage the burdens of home ownership. The typical new
resident is in his or her seventies. Often, the only source of funds
for the required deposit is the proceeds from the sale of a prior
residence. In many cases, taxpayers have owned their homes for many
years and inflation has created a gain of more than $125,000.
Consequently, these taxpayers are subjected to income tax on the gain
from selling their residence when they need the funds for the
continuing care facility.

The proposal would eliminate this problem by adding a section to
the definition of new residence which would allow a continuing care
facility to qualify as a replacement residence. This change will
allow taxpayers to avoid tax on any proceeds that they use for a
deposit in a continuing care facility.

Congress has created a definition of "qualified continuing care
facility" in §7872(g)(3). We propose that this definition be
utilized for purposes of the deferral under §1034.

6. PROPOSAL FOR
AMENDING I.R.C. §121

Regarding: A proposal to modify the measurement period for
residing in the principal residence for purposes of exclusion on sale
of residence incident to divorce

PRESENT LAW

Section 121 provides for an election to exclude up to $125,000 of
gain from the sale of a principal residence if the taxpayer is at
least age 55 and has owned and resided in the residence for at least
three of the preceding five years. Only one spouse is required to
satisfy those tests in order to be eligible for the exclusion but
that spouse alone must meet all the requirements. Married couples are
entitled to only one $125,000 exclusion between them if they file
jointly; if they file separately, they are entitled to only $62,500
each. Unmarried individuals are each entitled to exclusions of
$125,000.

RECOMMENDED CHANGE

Section 121 would be amended so that, if a residence is sold
pursuant to a divorce or separation, the eligible spouse(s) would be
able to utilize the gain exclusion if during the six (instead of the
present five) year period ending on the date of the sale or exchange,
the residence was used by the taxpayer as his or her principal
residence for periods aggregating three years or more.

REASON FOR CHANGE

Divorce is a unique transition for taxpayers. In most cases, one
spouse must involuntarily abandon the marital residence. In many
cases, as part of the property settlement, the residence is sold.
Until then, the spouse who abandoned the residence may live in
somewhat temporary lodging (e.g., rental). His or her last permanent
residence was the marital residence. A safe harbor is needed in the
law for such taxpayers to utilize §121 if the residence is sold
pursuant to a divorce settlement. Divorces often take more than two
years to complete. Further, it may take additional time to complete
sale of the residence after the agreement is finalized. Thus, an
extra year (i.e., three of six instead of three of five) is necessary
to permit §121 qualification.

7. PROPOSAL FOR
AMENDING I.R.C. §1034

Regarding: A proposal to allow capital losses to be deducted on
the sale of a principal residence by taxpayers

PRESENT LAW

Taxpayers generally may claim as a deduction any loss sustained
during the taxable year and not compensated by insurance or
otherwise. In the case of an individual, however, the deduction is
limited to: (1) losses incurred in a trade or business, (2) losses
incurred in any transaction entered into for profit though not
connected with a trade or business, and (3) catastrophic losses on
property that arise from fire, storm, shipwreck, or other casualty or
from theft. Losses from the sale or exchange of capital assets are
offset against capital gains and then deductible subject to the
limitations described above. In addition, taxpayers other than
corporations may deduct capital losses against up to $3,000 of
ordinary income each year. A loss on the sale or exchange of a
principal residence is treated as a nondeductible personal loss.

Gain on the sale or exchange of a principal residence generally is
includible in gross income and is subject to a maximum rate of 28
percent. If an individual purchases a new principal residence within
two years of selling the old residence, gain from the sale of the old
residence (if any) is recognized only to the extent that the
taxpayer’s adjusted sales price exceeds the taxpayer’s cost of
purchasing the new residence (sec. 1034). A taxpayer also may elect
to exclude from gross income up to $125,000 of gain from the sale of
a principal residence if the taxpayer: (1) has attained the age of 55
before the sale, and (2) has used the residence as the principal
residence for three or more years of the five years preceding the
sale of the residence (sec. 121). This election maybe made only once.

RECOMMENDED CHANGE

Losses from the sale or exchange of a principal residence would be
treated as a deductible capital loss rather than a nondeductible
personal loss. Therefore, the loss would be allowed to offset capital
gains and any excess could be deducted up to $3,000 in the current
year and the remainder carried over to future years.

REASON FOR CHANGE

There is an inequity in the current law with gains on sales of
personal residences being includible in gross income and taxed, but
losses not allowed as a deduction. The loss on the sale of a personal
residence often represents a true economic loss of the taxpayer. In
addition, many taxpayers are forced to sell their homes when they
change jobs and are not able to time the sale to when the real estate
market is on the rise. Many real estate prices in different parts of
the country have decreased, especially during downturns in the
economy and in the real estate market. Taxpayers in these
circumstances should receive some tax relief.

8. Draft letter for the
Senator to send to Treasury/IRS on periodic payments to CCRCs
qualifying partly for the qualified long-term care services/medical
expense itemized deduction

Specifically, IRC section 213(d)(1)(C) was changed to include
"qualified long-term care services" within the definition of medical
expenses for purposes of deductions. The term "qualified long-term
care services" is defined in new IRC section 7702B(c)(1) as
"necessary diagnostic, preventive, therapeutic, curing, treating,
mitigating, and rehabilitative services, and maintenance or personal
care services, which -- (A) are required by a chronically ill
individual, and (B) are provided pursuant to a plan of care
prescribed by a licensed health care practitioner."

A "licensed health care practitioner" is defined in IRC section
7702B(c)(4) as "..any physician (as defined in section 1861(r)(1) of
the Social Security Act) and any registered professional nurse,
licensed social worker, or other individual who meets such
requirements as may be prescribed by the Secretary. "

The key issue here is whether services provided by a continuing
care facility and home health care constitute services provided
pursuant to a plan of care prescribed by a "licensed health care
practitioner." If they do, a portion of the periodic payments to a
continuing care facility and payments for home health care should
qualify as medical expenses. Since it appears from the statute that
the Secretary will be issuing regulations to define "other
individual" under section 7702B(c)(4), I strongly suggest that this
issue be addressed in those or related regulations.

My understanding is that, in general, continuing care retirement
communities provide medical services and have a doctor on call,
nurses on staff, and assist with medications for residents in
exchange for some of the periodic amounts paid for to these
facilities. In addition, the services provided as part of a home
health care plan of action are those described as meeting the
definition of "qualified long-term care services." Therefore, it
seems that some of the periodic payments to such facilities and all
payments for home health care services should qualify as amounts for
qualified long-term care services eligible medical expense itemized
deduction. However, I leave it to you and your staff to better
analyze the situations and details to be covered by the regulations.
If the legislative intent is not clear or a legislative correction is
needed for this, I would be glad to talk to you further about this
and consider introducing legislation in this area.

I look forward to your review of this area and any forthcoming
regulation addressing this matter. Please let me know if I can be of
assistance with this effort.